It was a classic example of the old David versus Goliath story. This past June, small hedge fund/activist investor Engine No. 1 went up against the big oil company Exxon Mobil, and won three board seats after a months-long proxy battle. Later that month, the firm took its activist approach to a broader swath of companies, with the launch of the Engine No. 1 Transform 500 ETF (VOTE).
The firm launched the fund in June with $100 million in early capital from a multi-family office as well as a partnership with Betterment to integrate VOTE into all of its socially responsible investing strategies. The fund charges 5 basis points, and now has a total $256 million in assets.
More ETFs are in the works. The firm has filed for an active climate change-focused ETF.
And last January, Engine No. 1 brought on Yasmin Bilger, a former head of U.S. product specialist teams at J.P. Morgan Asset Management, as head of ETFs. Bilger recently chatted with WealthManagement.com about what’s next for the ETF business, how her firm hopes to change impact investing, and what’s holding advisors back from sustainable investing.
WealthManagement.com: What is Engine No. 1, and what is the firm’s investment philosophy?
Yasmin Bilger: At the firm level, the way we describe ourselves is first and foremost an investment firm. Our focus is tying environmental and social issues to economic outcomes. We were founded on a shared belief that the investments that a company makes in its employees, in its customers, in the community that it operates in, and the environment and are actually directly linked to its ability to create long-term shareholder value. A lot of the conversation in this space is centered around the ideology and morality of sustainability. And we are very much focused instead on the economic argument for specific environment and social issues.
When we’re analyzing a company, we think not only about traditional financial metrics, but also think about the positive and negative impacts that a company is having on things like an environment and social issues. Quite literally, the carbon they emit and the value associated with that, or the wages they’re paying their employees. We use all of that to come up with what we think is a true value for a firm. And that really informs what companies we invest in, and where we do our engagements.
Our active ownership approach is more like a private equity business than it is from what we’ve seen from traditional asset managers. We’re really focused on much more deep and focused engagements where we’re trying to have specific impacts and specific recommendations.
WM: How is VOTE different from other ESG ETFs out there?
YB: Most of what’s out there in the market in sustainable ETFs are funds that either do one of two things: They either exclude certain sectors or companies, or they re-weight, so they use some sort of ranking mechanism to lean into the companies that rank highly on some set of ESG metrics, and lean away from companies that rank poorly. They’re ESG by what they own. We see ourselves as ESG by what we do. The VOTE ETF itself does not re-weight or exclude. It really is just the largest 500 companies as defined by Morningstar’s index. And really that is intentional. We wanted to design a product that fit the investing framework of how the majority of the market invests. If you look at the top three largest ETFs in the U.S. ETF market, they’re over $1 trillion in assets, and they’re all market-cap weighted ETFs.
On the investing side, VOTE should actually intentionally look very similar to what most people have in their portfolios. What’s different is the active ownership side. Our voting policy looks in effect very differently from what you’d see from other asset managers out there. What we’ve tended to see historically from some of the larger asset managers is that they’ve historically voted against environmental and social shareholder proposals.
We can actually backtest how we would’ve voted before we launched in June. And if you look at that backtest, it would have a much higher support for those type of issues, to the tune of 65% to 85%.
On top of it, our engagement strategy is very different than traditional asset managers. You tend to find that traditional asset managers put out an impact report at the end of the year that talks about the number of companies they were engaged with and all the topics that were talked about, almost like a quantity focused exercise
Our goal is very specifically not to engage with all 500 companies with our portfolio. It’s to find the areas where we can be focused, have the most impact, and tie it back to shareholder value. What we would do is deeper engagements and fewer engagements.
WM: What would be the value in investing in your ETF versus another ETF tracked to the same index? Don’t all the investors in the S&P 500 or any market-cap weighted index benefit from the work you’re doing?
YB: We actually hope to be the tip of the spear on many of these topics. We think our size—allows us to do things that larger managers can’t do. We hope to bring people along. The case of Exxon is the best example of that. We would have definitionally never been successful if we weren’t able to convince other shareholders to join us. So we don’t see a problem with the shared benefit.
WM: What’s next for the ETF group?
YB: We built the platform really with the principle of long-term and scale and plan to launch more than one ETF. What we have next is a climate fund, so active equity. Think alpha and impact. It’s based on the linkage between environmental and social issues and long-term shareholder value. We’re also conceptualizing a suite of more active equity thematic strategies.
VOTE is very simple on the investing side—it’s just a market-cap weighted index that we track. It’s Morningstar’s version of the largest 500 companies. And where we’re really different is the active ownership work that we’re doing—the way we vote our shares, and the campaigns and engagements that we run. I say all that because that whole product line could be extended to other exposures—to the extent we actually found investors who were interested in helping us catalyze another version of VOTE.
WM: How will your active thematic ESG funds differ from others out there?
YB: There are a lot of climate ETFs out there that have two flavors to me. The first category are low tracking error [ETFs], that own most of the index and tweak a little bit what they own. That to me is not at all what we’re doing. We’re not passive; we’re a much more concentrated portfolio. That is because we’re active in nature. There are also thematic climate funds, which are concentrated and in some cases, active. But what you tend to find is that most of them are focused on green [investments]—for example, solar energy. If I think of the brand of Engine No. 1, frankly it’s in our name—we are leaning into the problem, not running away from it. A lot of what we are focused on is this idea of moving companies from brown to green, and for us that is really where the investing opportunity lies and where we think you can have the greatest impact.
WM: What other market-cap exposures will you consider for applying the VOTE concept?
YB: VOTE is really about keeping the investment side the way investors normally invest—as similar as possible to what people have and adding value through our active ownership work. We started with the largest 500 companies in the U.S. because that’s where the majority of people’s assets are today. But as we all know, there are a lot of other market cap exposures that are out there. A natural extension of that product line would be to continue to fill out where the largest buckets are of market cap investments. For example, we could consider a small-cap, a mid-cap, a total market.
WM: How do you think Engine No. 1 will impact the ETF industry?
YB: The ETF industry is now over $7 trillion. It’s a large market. If you look at the sustainable ETFs out there, they are growing, but are still a very small percentage of the overall total market. And my hope is that we can be considered the go-to provider for impact-focused ETFs, and I think the fact that we’re small and purpose-built is actually a huge strength of ours in doing so.
I think VOTE is actually, more specifically, really quite innovative in the context of the ETF market. For the most part, a lot of what investors face when it comes to sustainable ETFs is this worry around a trade-off on performance. I think VOTE really solves that in many ways for investors.
WM: There’s a big gap in the market in terms of financial advisors’ use of and education on sustainable and impact investing strategies. Why do you think that is?
YB: I spent a lot of time talking to financial advisors across various channels, of different sizes. And there are a few interesting insights I feel I’ve learned around what may be holding back the sustainable investing space. The first is that performance trade-off. I think there is a worry or hesitation by the financial advisor that if they try to put into the client portfolios a product that introduces tracking error that it creates noise in their client conversations, particularly products that don’t have a strong thesis for why the sustainability angle should outperform over time. I think that’s one really big key gap that the market has to solve for; I hoping we’re solving for it with VOTE.
The second is around this confusion of the language itself. I think the ESG metrics space has become very confusing for many advisors and investors. If you look at the various ESG ratings agencies out there, what you find is that there’s very a lack in correlation in how they’re actually measuring companies. You can find cases where companies are ranked very highly in one scoring system and very poorly by another. I think that creates a lot of confusion.
Lastly, I think advisors are struggling right now to bring to life the “so-what” of investing in the sustainable space. We like to call it the “theory of change”—what’s different about the world if an investor were to move money from their current fund to a fund focused on sustainability. I think it’s incumbent on us as an industry to bring this to life to end investors through specific stories that can make it relatable.
WM: How have advisors reacted to the VOTE ETF?
YB: The growth we’ve seen since we launched in June has really been from a variety of retail investors, financial advisors and institutional asset allocators. Particularly with advisors though, in our conversations, I do think that given some of those challenges that exist for the sustainable investing space, VOTE has actually helped to solve a number of them. Because it’s a market-cap exposure, it has minimized the challenge around typical tracking error performance differentials. It’s priced at 5 basis points, so from a cost perspective, it’s very similar to a market-cap ETF that they already have in their portfolios. We’re really focused on how we’re voting our shares and the campaigns and engagements we’re running, which really helps to give advisors some specific examples around the work that Engine No. 1 is doing from an active ownership angle to drive change.
Editor's note: The conversation has been edited for length and clarity.